<Page>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15()
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15() OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______ TO ________
COMMISSION FILE NUMBER 001-15693
-----------
CARRIER 1 INTERNATIONAL S.A.
(Exact name of Registrant as specified in its charter)
LUXEMBOURG 98-0199626
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
-----------
ROUTE D'ARLON 3
L-8009 STRASSEN, LUXEMBOURG
(011) (41-1) 297-2600
(ADDRESS, INCLUDING ZIP CODE, AND
TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
-----------
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes /X/ No / /
At November 12, 2001 there were 42,883,039 shares of Common Stock of
the registrant outstanding.
<Page>
In this report, "Carrier1 International" and "Carrier1 International
S.A." refer to Carrier 1 International S.A., a societe anonyme organized
under the laws of the Grand-Duchy of Luxembourg, and "Carrier1", "we", "our"
and "us" refers to Carrier1 International and its subsidiaries and their
predecessors, except where the context otherwise requires. References to "the
euro", "euros" or "(u)" are to the lawful currency of the European Monetary
Union and all references to "U.S. dollars", "dollars" or "$" are to the
lawful currency of the United States.
The statements contained in this report that are not historical
facts are "forward-looking" statements within the meaning of Section 21E of
the Securities Exchange Act of 1934 which can be identified by the use of
forward-looking terminology such as "believes", "expects", "may", "will",
"should" or "anticipates" or the negative thereof or other variations thereon
or comparable terminology, or by discussions of strategy that involve risks,
uncertainties and assumptions. These forward-looking statements include those
regarding Carrier1's ability to implement its business and financial plans,
its ability to develop and expand its business, its ability to reduce and
manage costs, its ability to design, configure, develop and operate its
networks successfully, its ability to continue increasing its consumer base,
its ability to take advantage of new technologies, its markets, including the
future growth of the European telecommunications market, the effects of
regulation, including tax regulations, litigation, its anticipated future
revenues, capital spending and financial resources and other statements
contained in this report regarding matters that are not historical facts.
Such forward-looking statements may be included in, but are not limited to,
those set forth in "Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operation."
We have based these forward-looking statements on our current
expectations and projections about future events and on industry
publications. We have not independently verified the data derived from
industry publications. Management of Carrier1 cautions the reader that these
forward-looking statements and performance are subject to risks,
uncertainties and other factors that could cause actual results to vary
materially from future results indicated, expressed or implied in such
forward-looking statements. No assurance can be given that the future results
will be achieved. Actual events or results may differ materially as a result
of such risks and uncertainties facing Carrier1. Such risks and uncertainties
include, but are not limited to:
- the success or failure of our tender offer for our high yield
notes;
- our expectation of net losses and negative cash flow;
- our lack of control over third parties on whom we rely for the
operation or maintenance of portions of our network;
- the competitiveness of the telecommunications industry and our
ability to compete successfully;
- difficulty we may experience in retaining or hiring employees;
- customers diverting traffic to another carrier based on small
price changes;
- customers or potential customers reducing, terminating or
choosing not to do business with us due to our financial
difficulties;
- loss of, or change of relationship with, one or more important
customers;
- terms required by our suppliers reducing our financial
flexibility;
- the high exposure of our revenue base to the financial
condition of other companies in the telecommunications sector;
- inherent risks of alliances, joint ventures and partnerships;
- adverse effects of the international scope of our operations
on our business;
- loss of government licenses, or the possibility of more
onerous government regulation;
- rapid change in our industry and technological competition;
- control of us by parties whose interests may not be aligned
with other holders of our securities;
- loss of customers and revenues if we are unable to improve and
adapt our operations and systems;
- inadequate interconnection and peering arrangements causing us
to incur higher termination costs than competitors;
- our inability to obtain sufficient cost-effective transmission
capacity delaying our market penetration;
- transmission costs continuing to be higher than target or the
need to make further capital expenditures to obtain capacity;
- incorrect estimates of our needs for capacity;
- difficulty enhancing our billing, customer and information
systems; and
2
<Page>
- enforcement of judgments against us requiring compliance with
non-U.S. law.
Certain information contained in this Report, including information
with respect to our plans and strategy for our business and related financing,
includes forward-looking statements that involve risk and uncertainties that are
detailed in our most recent Form 10-K as of December 31, 2000 and in our Offers
to Purchase and Consent Solicitations Statement, dated November 6, 2001, as
filed on Form 8-K on November 7, 2001.
3
<Page>
CARRIER1 INTERNATIONAL S.A.
FORM 10-Q
INDEX
PART I-FINANCIAL INFORMATION
<Table>
ITEM 1. FINANCIAL STATEMENTS 5
Consolidated Balance Sheets-September 30, 2001 (Unaudited) and December 31, 2000 5
Unaudited Consolidated Statements of Operations-Three and Nine Months Ended September 30, 2001 and 2000 6
Unaudited Consolidated Statement of Changes in Shareholders' Equity-Nine Months Ended September 30, 2001 7
Unaudited Consolidated Statements of Cash Flows-Nine Months Ended September 30, 2001 and 2000 8
Notes To Unaudited Consolidated Financial Statements-Three and Nine Months Ended September 30, 2001 and 2000 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 30
PART II-OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 32
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 32
ITEM 5. OTHER INFORMATION 32
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 32
Signatures 33
</Table>
4
<Page>
PART I-FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CARRIER1 INTERNATIONAL S.A. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2001 (UNAUDITED) AND DECEMBER 31, 2000
(In Thousands of U.S. Dollars, Except Share Information)
<Table>
<Caption>
SEPTEMBER 30, 2001 DECEMBER 31, 2000*
----------------------- ------------------
(UNAUDITED)(SEE NOTE 2)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 36,342 $ 162,162
Restricted cash 13,853 24,429
Restricted investments held in escrow - 29,951
Available-for-sale securities 83,510 198,186
Accounts receivable, net of allowance for doubtful accounts of
$32,489 and $5,659 respectively 88,272 77,625
Unbilled receivables 34,652 32,202
Value-added tax refunds receivable 46,046 35,741
Prepaid expenses and other current assets 24,875 19,334
----------------------- ------------------
Total current assets 327,550 579,630
PROPERTY AND EQUIPMENT-NET (See Note 3) 121,512 423,194
INVESTMENT IN RELATED PARTY (See Notes 8 and 11) 1,820 27,750
INVESTMENT-OTHER (See Note 11) 6 3,258
OTHER ASSETS 21,473 20,429
----------------------- ------------------
TOTAL $ 472,361 $ 1,054,261
======================= ==================
LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY
CURRENT LIABILITIES:
Accounts payable $ 91,216 $ 96,713
Accrued network costs 25,230 9,487
Accrued refile costs 44,489 34,705
Accrued interest 3,931 11,915
Accrued contract penalty charges 12,036 -
Restructuring reserve (See Note 10) 11,280 -
Value-added tax payables 19,440 8,234
Other liabilities 13,281 11,589
Deferred revenue 7,158 11,539
Short-term debt 1,489 2,838
----------------------- ------------------
Total current liabilities 229,550 187,020
DEFERRED REVENUE 102,023 103,496
LONG-TERM DEBT (See Notes 6 and 13):
Senior notes 235,517 237,888
Other long-term debt - 753
----------------------- ------------------
Total long-term debt 235,517 238,641
----------------------- ------------------
COMMITMENTS AND CONTINGENCIES (See Note 7)
Total liabilities 567,090 529,157
SHAREHOLDERS' (DEFICIT) EQUITY:
Common stock, $2 par value, 55,000,000 shares authorized, 42,875,466 and
42,844,204 issued and outstanding, respectively 85,751 85,688
Additional paid-in capital 666,224 666,205
Accumulated deficit (819,315) (219,666)
Accumulated other comprehensive loss (26,783) (6,532)
Common stock held in treasury, 73,923 and 73,337, respectively (606) (591)
----------------------- ------------------
Total shareholders' (deficit) equity (94,729) 525,104
----------------------- ------------------
TOTAL $ 472,361 $ 1,054,261
======================= ==================
</Table>
*Derived from audited consolidated financial statements.
See notes to unaudited consolidated financial statements.
5
<Page>
CARRIER1 INTERNATIONAL S.A. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 (SEE NOTE 2)
(In Thousands of U.S. Dollars, Except Per Share Information)
<Table>
<Caption>
NINE MONTHS NINE MONTHS
THREE MONTHS THREE MONTHS ENDED ENDED
ENDED ENDED SEPTEMBER 30, SEPTEMBER 30,
SEPTEMBER 30, 2001 SEPTEMBER 30, 2000 2001 2000
------------------ ------------------ ------------- -------------
REVENUES $ 87,025 $ 76,558 $ 284,635 $ 185,356
OPERATING EXPENSES:
Cost of services (exclusive of items shown
separately below) 114,226 76,346 307,767 189,349
Selling, general and administrative 18,455 8,699 66,859 25,502
Depreciation and amortization 18,416 9,201 48,040 22,580
Restructuring (See Note 10) 15,937 - 15,937 -
Impairment of long-lived assets (See Notes 3 and 11) 429,163 - 429,163 -
------------------ ------------------ ------------- -----------
Total operating expenses 596,197 94,246 867,766 237,431
------------------ ------------------ ------------- -----------
LOSS FROM OPERATIONS (509,172) (17,688) (583,131) (52,075)
------------------ ------------------ ------------- -----------
OTHER INCOME (EXPENSE):
Interest expense (7,814) (8,057) (23,889) (23,893)
Interest income 3,374 5,494 10,106 14,584
Currency exchange (loss) gain, net 18,962 (10,307) (2,330) (26,132)
Other, net (33) 4 (37) (2)
------------------ ------------------ ------------- -----------
Total other income (expense) 14,489 (12,866) (16,150) (35,443)
------------------ ------------------ ------------- -----------
LOSS BEFORE INCOME TAX (EXPENSE) BENEFIT AND EXTRAORDINARY
ITEM (494,683) (30,554) (599,281) (87,518)
INCOME TAX (EXPENSE) BENEFIT-Net of
valuation allowance (See Note 9) (368) - (368) -
------------------ ------------------ ------------- -----------
LOSS BEFORE EXTRAORDINARY ITEM (495,051) (30,554) (599,649) (87,518)
EXTRAORDINARY LOSS ON EARLY
EXTINGUISHMENT OF DEBT-Net of $0 tax
benefit (See Note 6) - - - (3,789)
------------------ ------------------ ------------- -----------
NET LOSS $ (495,051) $ (30,554) $ (599,649) $ (91,307)
================== ================== ============= ===========
LOSS PER SHARE (See Note 5):
Loss before extraordinary item:
Basic and diluted $ (11.55) $ (0.73) $ (13.99) $ (2.19)
Extraordinary loss on early extinguishment of
debt:
Basic and diluted - - - (0.10)
------------------ ------------------ ------------- -----------
Net loss:
Basic and diluted $ (11.55) $ (0.73) $ (13.99) $ (2.29)
================== ================== ============= ===========
</Table>
See notes to unaudited consolidated financial statements.
6
<Page>
CARRIER1 INTERNATIONAL S.A. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' (DEFICIT) EQUITY
(SEE NOTE 2)
NINE MONTHS ENDED SEPTEMBER 30, 2001
(In Thousands of U.S. Dollars, Except Share Information)
<Table>
<Caption>
ACCUMULATED COMMON
ADDITIONAL OTHER STOCK HELD
COMMON PAID-IN ACCUMULATED COMPREHENSIVE IN
STOCK CAPITAL DEFICIT INCOME (LOSS) TREASURY TOTAL
----------- ----------- ----------- -------------- ----------- ---------
BALANCE-December 31, 2000 $85,688 $666,205 $(219,666) $ (6,532) $(591) $525,104
Issuance of shares
(including treasury stock)
(32,912 shares) 63 19 3 85
Repurchase of shares (2,236
shares) (18) (18)
Comprehensive income
(loss):
Net loss (599,649) (599,649)
Other comprehensive
income (loss), net of
tax:
Currency translation
adjustments (20,748) (20,748)
Net unrealized loss
from
available-for-sale
securities (net of $0
tax) (807) (807)
Net realized gain
from
available-for-sale
securities (net of $0
tax) 1,304 1,304
Total comprehensive
loss (619,900)
----------- ----------- ----------- -------------- ----------- ---------
BALANCE-September 30, 2001 $85,751 $666,224 $(819,315) $(26,783) $(606) $(94,729)
=========== =========== =========== ============== =========== =========
</Table>
See notes to unaudited consolidated financial statements.
7
<Page>
CARRIER1 INTERNATIONAL S.A. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS (SEE NOTE 2)
NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(In Thousands of U.S. Dollars)
<Table>
<Caption>
NINE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2001 2000
------------------- -------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(599,649) $ (91,307)
Adjustments to reconcile net loss to net cash (used in) provided by operating
activities:
Depreciation and amortization 48,040 22,580
Impairment of long-lived assets included in restructuring expenses 4,635 -
Impairment of long-lived assets 429,163 -
Amortization of financing costs 759 1,260
Extraordinary loss on early extinguishment of debt - 3,789
Bad debt expense 25,932 948
Changes in operating assets and liabilities:
Restricted cash (5,093) (2,005)
Accounts, unbilled and value-added tax refunds receivables (51,905) (44,814)
Prepaid expenses and other current assets (5,966) (8,674)
Other assets (1,789) 312
Accounts payable and accrued liabilities 64,842 49,163
Short-term deferred revenue (2,152) -
Long-term deferred revenue (3,111) 79,445
---------- ---------
Net cash (used in) provided by operating activities (96,294) 10,697
---------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (170,117) (153,668)
Receipts from maturity of restricted investments held in escrow 28,561 58,227
Receipts from sale of available-for-sale securities 183,160 -
Purchases of available-for-sale securities (76,787) -
Increase in long-term investments (4,138) (28,585)
---------- ---------
Net cash used in investing activities (39,321) (124,026)
---------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of short-term debt - 29,726
Proceeds from issuance of long-term debt - 10,304
Proceeds from issuance of common stock 85 681,654
Payments on short-term debt - (38,397)
Payments on long-term debt (2,102) (106,777)
Purchase of treasury stock (18) (649)
Payments on restricted cash related to financing activities - (19,318)
Proceeds from restricted cash related to financing activities 14,450 5,480
---------- ---------
Net cash provided by financing activities 12,415 562,023
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS (2,620) (23,843)
---------- ---------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (125,820) 424,851
CASH AND CASH EQUIVALENTS:
Beginning of period 162,162 28,504
---------- ---------
End of period $ 36,342 $ 453,355
========== =========
</Table>
See notes to unaudited consolidated financial statements.
8
<Page>
CARRIER1 INTERNATIONAL S.A. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS (SEE NOTE 2)
NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(In Thousands of U.S. Dollars)
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest for the nine months ending September 30, 2001
and 2000 was $31,833 and $35,800, respectively.
SUPPLEMENTAL DISCLOSURE OF NON-CASH OPERATING AND INVESTING ACTIVITIES:
At September 30, 2001 and 2000, network asset purchases of
approximately $49,890 and $9,887, respectively, are included in accounts payable
and accrued network costs.
At December 31, 2000 and 1999, network asset purchases of approximately
$59,721 and $39,720 respectively, are included in accounts payable and accrued
network costs.
See notes to unaudited consolidated financial statements.
9
<Page>
CARRIER1 INTERNATIONAL S.A. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(In Thousands of U.S. Dollars, Except Share Information)
1. NATURE OF OPERATIONS
Carrier1 International S.A., its subsidiaries in Europe and its
subsidiary in the United States (collectively, "Carrier1"), operate in the
telecommunications industry offering voice and data services. Carrier1 offers
these services primarily to other telecommunications service providers.
Carrier1 International S.A. is a societe anonyme organized under the laws of
the Grand-Duchy of Luxembourg and has adopted a fiscal year end of December
31.
2. UNAUDITED FINANCIAL INFORMATION
The financial information included herein is unaudited; however, the
information reflects all adjustments (consisting of normal recurring
adjustments and certain asset impairment and other charges) that are, in the
opinion of management, necessary for a fair presentation of the Company's
financial position, results of operations, changes in shareholders' equity,
and cash flows for the interim periods presented. The results of operations
for the three and nine months ended September 30, 2001 are not necessarily
indicative of the results to be expected for the full year.
These interim financial statements do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States of America for complete financial statements and should be
read in conjunction with the consolidated balance sheet of Carrier1 at December
31, 2000 and the related consolidated statements of operations, shareholders
equity and cash flows for the year ended December 31, 2000.
3. PROPERTY AND EQUIPMENT AND RELATED IMPAIRMENT CHARGES
Property and equipment at September 30, 2001 and December 31, 2000,
respectively, consist of the following:
<Table>
<Caption>
SEPTEMBER 30, DECEMBER 31,
2001 2000
------------- ------------
Network equipment $ 29,373 $ 168,597
Owned fiber network 12,679 124,682
Indefeasible right-of-use investments 27,835 98,201
Leasehold improvements 37,874 25,694
Furniture, fixtures and office equipment 19,975 16,534
Construction in progress 10,113 36,682
------------- ------------
137,849 470,390
Less: accumulated depreciation and amortization (16,337) (47,196)
------------- ------------
Property and equipment, net $ 121,512 $ 423,194
============= ============
</Table>
Carrier1 accounts for impairment of long-lived assets in accordance
with Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of."
SFAS 121 requires that long-lived assets and certain identifiable
intangibles to be held and used by an entity be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. Carrier1 periodically evaluates whether events and
circumstances have occurred that indicate possible impairment.
In performing the review, the entity estimates the undiscounted
net future cash flows expected to result from the use of the related asset or
asset group. If the sum of the estimated net future cash flows (undiscounted and
without interest charges) is less than the carrying amount of the related asset
or asset group, an impairment loss is recognized. Measurement of an impairment
loss for long-lived assets and identifiable intangibles that an entity expects
to hold and use is based on the fair value of the asset. The fair value
of an asset is the amount at which the asset could be bought or sold in a
current transaction between willing parties, that is, other than in a forced or
liquidation sale.
In 2000, Carrier1 entered into an agreement to purchase an IRU (the "UK
Ring") in the United Kingdom from 360 Networks ("360"). The network assets were
not yet completed by the time 360 filed for bankruptcy. After unsuccessful
negotiations with the administrator, management decided to abandon its efforts
to place the UK Ring into service in September 2001, and determined that it was
appropriate to take an impairment charge of approximately $26,173 relating to
the abandonment.
In light of recent conditions in the telecommunications industry and
the world economy, Carrier1 has conducted a review of the carrying amount of its
network assets. It determined that the network assets group was the lowest level
within property and equipment at which cash flows could be reliably identified
and estimated. Carrier1 concluded that the estimated future undiscounted cash
flows expected to be generated by its network assets would be less than their
carrying amount. As a result of the review, the Company recorded an asset
impairment charge in the third quarter of 2001 of approximately $370,166
relating to the write-down of the carrying value of its network assets
to their estimated fair values based on a third party valuation analysis. The
valuation analysis used to ascertain fair value reflected the value of the
assets as a going concern and contemplates retention of the network assets at
their present location for continuation as part of the current operations. The
valuation analysis included the cost, income and market approaches to valuation
of assets, with primary consideration given to the income approach on the basis
of projected earnings and cash flows.
The Company's impairment of long-lived assets recorded in the third quarter of
2001 consists of the following:
<Table>
Impairment of network assets $ 370,166
Abandonment of network assets 26,173
Impairment of investments in related party and other
equity investments (See Note 11) 32,824
---------
Total impairment of long-lived assets $ 429,163
=========
</Table>
4. CHANGE IN FUNCTIONAL CURRENCY
During the third quarter of 2000, Carrier1 determined that the
functional currency of the Luxembourg holding company, Carrier1 International
S.A., had clearly changed from the U.S. dollar to the euro due to significant
changes in economic facts and circumstances underlying Carrier1's business. The
functional currencies of Carrier1's subsidiaries have not changed and, in all
instances, are the respective local currencies.
Carrier1 applied this change prospectively as of the beginning of the
third quarter of 2000, in accordance with Accounting Principles Board Opinion
No. 20 "Accounting Changes." As a result of the change, transactions entered
into by Carrier1 International S.A. that are denominated in currencies other
than the euro are now translated into euros in accordance with Statement of
Financial Accounting Standard No. 52, "Foreign Currency Translation."
The net effect of this change in functional currency for the nine
months ended September 30, 2001 was to reduce the net currency exchange loss
and the net loss reported in the statement of operations for the nine months
ended September 30, 2001 by approximately $12,911 and to increase the
negative currency translation adjustment component of other comprehensive
loss reported in the consolidated statement of changes in shareholders'
equity for the nine months ended September 30, 2001 by approximately $12,911.
For the three months ended September 30, 2000 the effect was to reduce the
net currency exchange loss and the net loss reported in the statement of
operations by approximately $17,800 and to increase the negative currency
translation adjustment component of other comprehensive loss reported in the
statement of shareholders' equity by approximately $17,800. The cumulative
effect of this change in functional currency as of September 30, 2001 was to
increase the cumulative negative currency translation adjustment component of
other comprehensive loss reported in the consolidated statement of changes in
shareholders' equity by approximately $29,923. Also as a result of the
change, both basic and diluted loss per share for the nine months ended
September 30, 2001 were decreased by $0.30 and the three months ended
September 30, 2000 were decreased by $0.43.
10
<Page>
5. LOSS PER SHARE
The following details the loss per share calculations for the three and
nine months ended September 30, 2001 and September 30, 2000:
<Table>
<Caption>
NINE MONTHS NINE MONTHS
THREE MONTHS THREE MONTHS ENDED ENDED
ENDED ENDED SEPTEMBER 30, SEPTEMBER 30,
SEPTEMBER 30, 2001 SEPTEMBER 30, 2000 2001 2000
------------------ ------------------ ------------- -------------
Loss from operations $ (509,172) $ (17,688) $ (583,131) $ (52,075)
=============== ================ =========== ===========
Loss before extraordinary item (495,051) (30,554) (599,649) (87,518)
Extraordinary loss from early extinguishment of debt $ - $ - $ - $ (3,789)
--------------- ---------------- ----------- -----------
Net loss $ (495,051) $ (30,554) $ (599,649) $ (91,307)
=============== ================ =========== ===========
Total number of shares used to compute basic and diluted
loss per share 42,872,000 41,648,000 42,862,000 39,923,000
LOSS PER SHARE:
Loss from operations:
Basic and diluted $ (11.88) $ (0.42) $ (13.60) $ (1.30)
=============== ================ =========== ===========
Loss before extraordinary item:
Basic and diluted (11.55) (0.73) (13.99) (2.19)
Extraordinary loss:
Basic and diluted $ - $ - $ - $ (0.10)
--------------- ---------------- ----------- -----------
Net loss:
Basic and diluted $ (11.55) $ (0.73) $ (13.99) $ (2.29)
=============== ================ =========== ===========
</Table>
Potential dilutive securities have been excluded from the computation
for the three and nine months ended September 30, 2001 and September 30, 2000 as
their effect is anti-dilutive. Had Carrier1 been in a net income position, the
number of weighted-average shares used to compute diluted earnings per share
would have included an additional 675,000 and 3,264,000 shares for the three and
nine months ended September 30, 2001, respectively and 5,230,000 shares for the
three and nine months ended September 30, 2000, related to outstanding warrants,
stock options and stock subscriptions (determined using the treasury stock
method at the estimated average market value).
11
<Page>
6. DEBT
During the nine months ended September 30, 2000, the early
retirement of an interim credit agreement with Morgan Stanley Senior Funding,
Inc. and Citibank N.A. and a financing facility with Nortel Networks Inc.
resulted in an after-tax extraordinary loss of $3,789, or $0.10 per share.
7. PURCHASE COMMITMENTS
On September 29, 2001, Carrier1 signed a binding memorandum of
understanding with a French company. This memorandum of understanding
amending and restated the original binding letter of intent dated, December
8, 2000, to exchange various capacities and ducts. Under the binding
memorandum of understanding, Carrier1 will provide a 15-year indefeasible
right of use, or IRU, for twenty-two fiber pairs in Italy for total
consideration of (u)1,012 ($921) with delivery expected in November 2001.
Carrier1 will also provide two ducts on its Milan Metro Ring for total
consideration of (u)2,060 ($1,874), with delivery expected in February 2002.
Carrier1 will receive: a 16-year IRU allowing it to choose various fiber
pairs from a fiber bank for total consideration of (u)7,430 ($6,760); an
additional 16-year IRU for an additional fiber bank of various fiber pairs
that will not be delivered until January 2003 for total consideration of
(u)1,000 ($910); and a 15-year IRU for one-fiber pair between Italy and
Switzerland for total consideration of (u)1,512 ($1,376). The memorandum of
understanding also provides that Carrier1 will make payments for rack fees,
annual rights-of-way and maintenance costs. As of September 30, 2001,
Carrier1 has paid (u)3,253 ($2,960) under the terms of the memorandum of
understanding.
8. RELATED PARTY TRANSACTIONS
In January 2001, Carrier1 invested an additional $4,324 in DigiPlex
S.A., a related party. In the third quarter of 2001, Carrier1 wrote-down its
investment in DigiPlex S.A. by $29,194 to an amount of $1,820 at September
30, 2001 (see Note 11). In addition, Carrier1 forgave a $97 loan to one of
its former employees.
9. INCOME TAXES
Carrier1 has tax loss carryforwards of approximately $168,314 at
September 30, 2001. The ability of Carrier1 to fully realize deferred tax
assets related to these tax loss carryforwards in future years is contingent
upon its success in generating sufficient levels of taxable income before the
statutory expiration periods for utilizing such net operating losses lapses.
Due to its limited history, Carrier1 was unable to conclude that realization
of such deferred tax assets in the near future was more likely than not.
Accordingly, a valuation allowance was recorded to offset the full amount of
such assets.
12
<Page>
10. RESTRUCTURING
In an effort to reduce costs and improve productivity, Carrier1
announced in September 2001 a plan approved by the board to restructure its
operations by reducing headcount and closing certain offices and data
centers. As a result, Carrier1 recorded a restructuring charge of $15,937 in
accordance with Emerging Issues Task Force Abstract 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit
an Activity, including Certain Costs Incurred in a Restructuring."
Of the total restructuring charge, $5,013 relates to employee
termination and severance programs. Prior to September 30, 2001, Carrier1
identified and notified approximately 125 employees which will be terminated
in the near future. These reductions will take place in each business segment
and geographic area of the company and in all major functions. The charge for
employee termination and severance programs was based on the number of
employees that will be terminated and the severance payments required by
contractual obligations and local law.
Facility and lease termination costs include the lease cancellation
penalties and the lease costs for certain office facilities that would no
longer be used after March 31, 2002. These facilities include sales and
administrative offices including Berlin, Brussels, Dusseldorf, Madrid,
Saarbruken and Vienna and data centers.
The impairment charge referred to in the table below for property
and equipment represents the write-down to fair value of certain leasehold
improvements and furniture and office fixtures to be disposed of or scrapped
and the recognition of impairment losses for assets to be used up to the
office closing dates for those offices to be closed. For certain offices to
be operated for a period of time, Carrier1 determined that the sum of the
expected future cash flows (undiscounted and without interest charges) was
less than the carrying amount of the property and equipment related to these
offices. Accordingly, an impairment loss was recorded to write-down these
certain furniture and office fixtures for these offices to their estimated
fair values. The fair value of such depreciable assets that remain in use are
depreciated over the asset's remaining useful life. Fair values for the
furniture and office fixtures were determined based on management's best
estimates considering the used equipment market.
<Table>
<Caption>
EMPLOYEE
TERMINATION FACILITY AND NON-CASH
AND LEASE WRITE-DOWN
SEVERANCE TERMINATION OF PROPERTY
PROGRAMS COST AND EQUIPMENT TOTAL
------------ ------------ ------------- -----------
Balance at December 31, 2000 - - - -
Charge to income $ 5,013 $ 6,289 $ 4,635 $ 15,937
Non-cash utilized - - (4,635) (4,635)
Other (10) (12) - (22)
-------- --------- --------- --------
Balance at September 30, 2001 $ 5,003 $ 6,277 $ - $ 11,280
======== ========= ========= ========
</Table>
13
<Page>
11. IMPAIRMENT OF INVESTMENTS IN RELATED PARTY AND OTHER ENTITIES
As part of its SFAS 121 impairment review, Carrier1 wrote-down
approximately $32,824 of other impaired long-lived assets in addition to the
write down of its network assets discussed in Note 3. These write-downs
primarily included $29,194 on its investment in DigiPlex S.A. and $3,157 on
its investment in Servecast.com Ltd. included in investments in related party
and other investments. The remaining write-down related to other equity
investments. Based on recent industry trends and management's current
expectation for the sector, sustained benefit from these assets is unlikely.
Based on Carrier1's analysis of future undiscounted net cash flow estimates,
these assets have been written-down to their estimated fair value, which was
determined by discounting the net future anticipated cash flows.
12. SEGMENT INFORMATION
Summarized financial information concerning Carrier1's reportable
segments for the nine months ended September 30, 2001 and September 30, 2000
is shown in the following table. The "Other" column includes unallocated
shared network and corporate-related assets which are all assets other than
network equipment that has been identified as relating to a specific segment.
NINE MONTHS ENDED SEPTEMBER 30, 2001:
<Table>
<Caption>
VOICE DATA
SERVICES SERVICES OTHER CONSOLIDATED
--------- -------- --------- --------------
Revenues $ 189,324 $ 95,311 $ 284,635
Fixed cost contribution (11,149) 36,952 25,803
Identifiable assets 4,142 4,677 $ 112,693 121,512
</Table>
NINE MONTHS ENDED SEPTEMBER 30, 2000:
<Table>
<Caption>
VOICE DATA
SERVICES SERVICES OTHER CONSOLIDATED
--------- -------- --------- --------------
Revenues $ 158,051 $ 27,305 $ 185,356
Fixed cost contribution 13,769 21,039 34,808
Identifiable assets 26,976 8,235 $ 919,980 955,191
</Table>
14
<Page>
The following table reconciles the fixed cost contribution for
reportable segments to the loss before income tax benefit for the nine months
ended September 30, 2001 and September 30, 2000:
<Table>
<Caption>
SEPTEMBER 30, SEPTEMBER 30,
2001 2000
------------- --------------
Total fixed cost contribution for reportable segments $ 25,803 $ 34,808
Unallocated amounts:
Unallocated cost of services (exclusive of items shown
separately below) (48,935) (38,801)
Selling, general and administrative expenses (66,859) (25,502)
Depreciation and amortization (48,040) (22,580)
Restructuring (15,937) -
Impairment of long-lived assets (429,163) -
Other expense (16,150) (35,443)
---------- ----------
Loss before income tax (expense) benefit and extraordinary item $(599,281) $ (87,518)
========== ==========
</Table>
Unallocated cost of services include network and transmission costs
that are shared by the voice and data services segments.
13. SUBSEQUENT EVENTS
SENIOR NOTE TENDER OFFER
On November 6, 2001, Carrier1 commenced a cash tender offer and
consent solicitation for amendments to the indentures (together the "Tender
Offer") for all of Carrier1's outstanding high yield senior notes. Pursuant
to the terms of the Tender Offer, note holders are being offered the
following amounts in cash in return for tendering their senior notes and
providing their consents.
The consideration offered for Carrier1's outstanding senior euro
notes and senior dollar notes is, per one thousand euros or one thousand U.S.
Dollars tendered, (u)85,000 in 13.25% senior euro notes due 2009 for (u)182.50
and $160,000 in 13.25% senior dollar notes due 2009 for $182.50, plus accrued
interest. Tendering holders whose notes are accepted for purchase also will
receive accrued interest up to, but not including, the payment date.
The Tender Offer will be conditioned upon the receipt of tenders for
more than 50 percent of the principal amount of each of Carrier's outstanding
senior euro notes and senior dollar notes taken individually and other
standard conditions. The Tender Offer will expire on December 5, 2001, unless
extended.
Management estimates that if all notes are tendered and accepted for
purchase, Carrier1 will pay approximately $57,000, including accrued interest
and related fees and costs. The Tender Offer will be funded through cash and
marketable securities.
If the Tender Offer is not successful and the indentures are not
amended as proposed, Carrier1's ability to continue to fund its operations
depends upon whether it can reduce capital expenditures and costs
significantly, eliminate all or a substantial portion of its debt and
conserve cash required to fund its operations until it is cash flow positive.
RESTRICTED CASH
On October 1, 2001, Carrier1 restricted further cash of $4,104 for
future personnel costs.
15
<Page>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS OF OUR FINANCIAL CONDITION AND
RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION WITH OUR UNAUDITED
CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES. CERTAIN INFORMATION
CONTAINED IN THE DISCUSSION AND ANALYSIS OR SET FORTH ELSEWHERE IN THIS
REPORT, INCLUDING INFORMATION WITH RESPECT TO OUR PLANS AND STRATEGY FOR OUR
BUSINESS AND RELATED FINANCING, CONTAINS FORWARD-LOOKING STATEMENTS THAT
INVOLVE RISK AND UNCERTAINTIES, AS REFERRED TO AT THE BEGINNING OF THIS FORM
10-Q AND AS DETAILED IN OUR MOST RECENT FORM 10-K AS OF DECEMBER 31, 2000 AND
IN OUR OFFERS TO PURCHASE AND CONSENT SOLICITATIONS STATEMENT, DATED NOVEMBER 6,
2001, AS FILED ON FORM 8-K ON NOVEMBER 7, 2001.
OVERVIEW
Conditions in the global economy, and particularly in the
telecommunications sector, worsened significantly during the third quarter of
2001. The events of September 11 further compounded the worsening global
economic situation. Management believes that the sector is unlikely to
recover in the near term, but continues to believe in the long-term prospects
of the Company's business. Carrier1 has continued to be affected by the
overall economic slowdown and specifically the slowdown in the
telecommunications industry. In light of these recent conditions, Carrier1
conducted a review of its assets and made substantial write-downs in the
third quarter of 2001 as described below. In order to respond to the
worsening operating and financial environment, Carrier1 has initiated several
key activities and programs aiming to reduce the Company's cash consumption,
lower operating expenditures, reduce its exposure to higher risk customers
(especially in its voice services segment) in order to reduce bad debt
expenses, and improve its working capital position. The combined aim of these
actions is to ensure that Carrier1 continues to have the necessary funding
sources to operate its business and serve its customers.
WRITE DOWN OF ASSETS
The rapid, steep downturns in the telecommunications industry and
related financial markets have increased pressure on Carrier1's margins
resulting in an unstable customer base and negative cash flows higher than
anticipated, which management believes will continue in the near term. These
events have created acute circumstances regarding the valuation of long-lived
assets, particularly in the third quarter of 2001.
Statement of Financial Accounting Standards No. 121 "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of", or
SFAS 121, requires that long-lived assets and certain identifiable intangibles
to be held and used by an entity be reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Carrer1 periodically evaluates whether events and circumstances
have occurred that indicate possible impairment
In performing the review, the entity estimates the undiscounted net
future cash flows expected to result from the use of the related asset or
asset group. If the sum of the estimated net future cash flows (undiscounted
and without interest charges) is less than the carrying amount of the related
asset or asset group, an impairment loss is recognized. Measurement of an
impairment loss for long-lived assets and identifiable intangibles that an
entity expects to hold and use is based on the fair value of the asset. The
fair value of an asset is the amount at which the asset could be bought or
sold in a current transaction between willing parties, that is, other than in
a forced or liquidation sale.
Carrier1 conducted a review of its assets under SFAS 121 and made total
write-downs in the third quarter of approximately $429.2 million, including a
write-down of approximately $370.2 million to its network assets group, as well
as a write-down of approximately $59.0 million to certain investments and
network assets. See Notes 3 and 11 in Carrier1's unconsolidated financial
statements and "Impairment of Long-Lived Assets" in the discussion below of the
results of operations for the third quarter and the nine month period ended
September 30, 2001.
16
<Page>
Carrier1 will continue to evaluate its assets on the basis of generally
accepted accounting principles in the United States of America and relevant
securities market regulations. Future evaluations may lead to further
write-downs and adjustments that may have materially adverse effects on
Carrier1's financial performance.
Carrier1's board of directors and management is currently evaluating
the implications of the Company's US GAAP consolidated losses for the third
quarter in the various jurisdictions in which the Company and its
subsidiaries are organized.
REDUCTION OF BAD DEBT AND CAPITAL EXPENDITURE
In recent quarters, Carrier1 has experienced significant bad debt
expenses relating to customers that were unable to pay for the services Carrier1
provided. In order to minimize bad debt in the future, Carrier1 has revised its
credit policies, instituted strict collection policies, increased billing
frequency, and instructed its organization to focus on receivables
management. As a result, Carrier1's bad debt expense for the third quarter of
2001 was $2.2 million, compared with $16.8 million during the previous
quarter. Carrier1 has also focused on reducing its capital expenditures in
order to conserve cash resources. This has been accomplished by minimizing
further network construction, canceling certain equipment purchases and
concentrating on its core markets and services. As a result, Carrier1's
capital expenditures decreased to $17.1 million during this quarter from
$43.8 million during the previous quarter.
RESTRUCTURING AND OTHER CHARGES
In order to lower Carrier1's overall operating expenses, the Company
decided to reduce its total staff by approximately 40% across all functions. As
part of the cost cutting program, Carrier1 decided to close a number of offices
in an effort to concentrate on offering its services in its key geographic
markets. Carrier1 estimates that these actions will lower annual expenses by
approximately $15 million. The reduction of staff, office space and other
related transactions led to Carrier1 taking a one-time restructuring charge of
$15.9 million.
Carrier1 has been in the process of renegotiating certain commercial
contracts, including its agreement with America Online, or AOL. In order to
properly reflect the status of these negotiations, Carrier1 has recorded
one-time charges of $15.2 million. These charges include the issuance of a
credit note and certain penalty charges relating to the AOL agreement and
anticipated cancellation charges of local loop and other third party networks
relating to Carrier1's networks in the United Kingdom.
TENDER OFFER AND CONSENT SOLICITATION FOR CARRIER1'S HIGH YIELD NOTES
Subsequent to the third quarter, on November 6, 2001, Carrier1
announced a Tender Offer for all of its outstanding high-yield notes. The
purchase price in the Tender Offer is (u)182.50 per (u)1,000 tendered on the
(u)85 million in 13.25% senior euro notes due 2009 and $182.50 per $1,000
tendered on the $160 million in 13.25% senior dollar notes due 2009, plus
accrued interest.
Current conditions in the capital markets make it unlikely that
Carrier1 will be able to raise additional capital to refinance its long-term
debt or fund its operations, given Carrier1's operating performance and existing
capital structure. As a result, Carrier1 now believes that it could experience
difficulty in meeting its August 2002 interest payment obligations on its notes.
Accordingly, Carrier1's ability to continue to fund its operations depends upon
whether it can reduce capital expenditure and costs significantly, eliminate all
or a substantial portion of its debt and conserve cash required to fund its
operations until it is cash-flow positive.
Considering Carrier1's financial condition and business prospects in
the current economic climate, Carrier1's board of directors approved steps in
the third quarter to reduce its costs, including making large reductions in
staff and closing certain facilities. Carrier1 does not believe, however, that
these steps alone will be adequate to assure continued funding of its operations
and believes that a significant reduction in indebtedness is also required.
Therefore, the Company is making the Tender Offer as part of Carrier1's
overall effort to eliminate or reduce its indebtedness substantially. This will
significantly decrease Carrier1's interest burden and is expected to improve
Carrier1's ability to continue to fund its operations.
Successful completion of the Tender Offer and adoption of the proposed
amendments to the indentures will permit Carrier1 greater financial and
operating flexibility as it assesses how best to continue to develop its
business and to continue to pursue strategic opportunities, including alliances,
acquisitions, business combinations and other similar transactions. Carrier1 has
no current arrangements or understandings to enter into any such transaction and
there can be no assurance that any such transaction will be entered into or
concluded. Carrier1 believes that it may be unable to
17
<Page>
participate in any such transaction unless it reduces its indebtedness
substantially and adopts the proposed amendments to the indentures. Carrier1
believes the Tender Offer is in the best interest of Carrier1 and the holders
of all its securities.
The indentures relating to the notes impose significant operating and
financial restrictions on Carrier1. They provide that upon a change of control,
each noteholder will have the right to require Carrier1 to purchase all or a
portion of the holder's notes at a fixed consideration. If Carrier1 is unable to
obtain the funds necessary to satisfy that obligation, this provision could
delay, deter or prevent a change of control transaction. If the Tender Offer is
not successful and the indentures are not amended as proposed in the Tender
Offer, the restrictions in the indentures may substantially limit or prohibit
Carrier1 from taking various actions, including incurring additional debt,
selling assets, engaging in mergers, consolidations or other business
combinations, repurchasing or redeeming its shares, or otherwise capitalizing on
business opportunities.
Payment of the purchase price and interest on completion of the
Tender Offer, if it is successful, will significantly reduce the Company's
total cash resources. Such significant reduction may have a material adverse
effect on the Company's funding and liquidity position. The amount of any
such reduction would depend upon the level of success of the Tender Offer.
18
<Page>
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
SUMMARY TABLE
<Table>
<Caption>
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2001 2000 2001 2000
------------- ------------- ------------- -------------
$000, EXCEPT SHARES AND PER SHARE DATA
Voice services revenue $ 61,675 $ 62,416 $ 189,324 $ 158,051
Data services revenue 25,350 14,142 95,311 27,305
----------- ----------- ----------- -----------
TOTAL REVENUE 87,025 76,558 284,635 185,356
Cost of services (exclusive of amounts shown
separately below) 114,226 76,346 307,767 189,349
Selling, general and administrative expenses 18,455 8,699 66,859 25,502
----------- ----------- ----------- -----------
EBITDA (45,656) (8,487) (89,991) (29,495)
Depreciation and amortization 18,416 9,201 48,040 22,580
Restructuring 15,937 - 15,937 -
Impairment of long-lived assets 429,163 - 429,163 -
OTHER INCOME (EXPENSE):
Interest expense (7,814) (8,057) (23,889) (23,893)
Interest income 3,374 5,494 10,106 14,584
Currency exchange (loss) gain, net 18,962 (10,307) (2,330) (26,132)
Other income (expense) (33) 4 (37) (2)
----------- ----------- ----------- -----------
Total other income (expense) 14,489 (12,866) (16,150) (35,443)
----------- ----------- ----------- -----------
LOSS BEFORE INCOME TAX (EXPENSE) BENEFIT AND
EXTRAORDINARY ITEM (494,683) (30,554) (599,281) (87,518)
Income tax (expense) benefit (368) - (368) -
----------- ----------- ----------- -----------
LOSS BEFORE EXTRAORDINARY ITEM (495,051) (30,554) (599,649) (87,518)
Extraordinary loss on early extinguishment of
debt - - - (3,789)
----------- ----------- ----------- -----------
NET LOSS $ (495,051) $ (30,554) $ (599,649) $ (91,307)
=========== =========== =========== ===========
BASIC AND DILUTED LOSS PER SHARE:
Loss before extraordinary item $ (11.55) $ (0.73) $ (13.99) $ (2.19)
Extraordinary loss on early extinguishment of
debt - - - (0.10)
----------- ----------- ----------- -----------
Net loss $ (11.55) $ (0.73) $ (13.99) $ (2.29)
=========== =========== =========== ===========
Weighted average shares outstanding 42,872,000 41,648,000 42,862,000 39,923,000
</Table>
19
<Page>
We define EBITDA as earnings before interest, taxes, depreciation,
amortization, restructuring, impairment of long-lived assets, foreign
currency exchange gains or losses, other income (expense) and extraordinary
items. EBITDA is used by management and certain investors as an indicator of
a company's ability to service debt and to satisfy its capital requirements.
However, EBITDA is not a measure of financial performance under accounting
principles generally accepted in the United States of America, or US GAAP,
and should not be considered as an alternative to cash flows from operating,
investing or financing activities as a measure of liquidity or an alternative
to net income as indications of our operating performance or any other
measure of performance derived under US GAAP. EBITDA as presented may not be
comparable to other similarly titled measures of other companies or to
similarly titled measures as calculated under our debt agreements.
THREE MONTHS ENDED SEPTEMBER 30, 2001 AS COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 2000:
REVENUE
Revenue for the three months ended September 30, 2001 was
approximately $87.0 million, representing an increase of approximately 14%
over revenue for the three months ended September 30, 2000 of approximately
$76.6 million. We divide our revenue into two principal categories: voice
services revenue and data services revenue. Voice services revenue decreased
slightly from $62.4 million for the three months ended September 30, 2000 to
$61.7 million for the three months ended September 30, 2001. Data services
revenue increased from $14.2 million for the three months ended September 30,
2000 to $25.3 million for the three months ended September 30, 2001. The
increase of revenue is mainly associated with the increase in demand for our
data services, especially our managed modem services.
VOICE SERVICES: Revenue from wholesale voice services and enhanced voice
services (calling cards, premium number services and other enhanced voice
services) for the three months ended September 30, 2001 and 2000 was
approximately $61.7 million and $62.4 million, respectively. Revenue declined
despite increased traffic volumes due to lower average revenues per minute.
Voice traffic volume during the three months ended September 30, 2001 was
approximately 527 million minutes compared with approximately 437 million
minutes during the three months ended September 30, 2000. The average revenue
per minute during the three months ended September 30, 2001 decreased
approximately 18% compared with the three months ended September 30, 2000.
The price decrease reflects a change in traffic mix as well as overall price
decreases for voice services as a result of increased competition. We believe
prices may stabilize if the number of direct competitors decreases as the
telecommunications industry continues to experience business failures and
further consolidation.
We have continued to implement the actions outlined in our previous
quarter's Form 10-Q filing such as the discontinuance of commercial
relationships with voice customers and voice customer groups that may expose
us to bad debt in the future or provide us with an inadequate return on
capital. We believe that these actions have been successful to date. However,
such actions might decrease our revenues over the short to medium term.
DATA SERVICES: Repetitive data services revenue - the revenue we derive from
Internet transport, Internet access services, bandwidth, infrastructure, and
data center services--was approximately $25.3 million for the three months
ended September 30, 2001, representing a 153% increase over revenue for the
three months ended September 30, 2000 of approximately $10.0 million. This
increase was primarily driven by increases in revenue from bandwidth,
infrastructure and VISP services. The increase was offset by $3.2 million as
a result of the resolution of a dispute with AOL regarding its acceptance
date for those services. We did not record any significant non-recurring data
revenues or one-time sales, such as duct, bandwidth IRU, and fiber sales,
during the three months ended September 30, 2001. During the third quarter of
2000, we recognized revenue of approximately $4.2 million from one bandwidth
IRU contract that qualified as a sales-type lease.
20
<Page>
COST OF SERVICES
Cost of services (exclusive of items shown separately) for the three
months ended September 30, 2001 was approximately $114.2 million,
representing a 50% increase over cost of services for the three months ended
September 30, 2000 of approximately $76.3 million. Depreciation of our
network assets is included in depreciation and amortization.
Cost of services consists of voice and Internet interconnection and
termination costs, network operating costs, transmission costs, temporary or
permanent leases for transmission capacity and costs related to duct,
bandwidth IRU, and fiber sales. The increase from the third quarter of 2000
to the third quarter of 2001 was primarily attributable to: interconnection
payments associated with the volume increase in traffic for our voice
services; additional network operating costs associated with the increased
demand for our repetitive data services; VISP termination costs, which were
new in 2001; the development of new services; and our geographic expansion.
In addition, we incurred $12.0 million of one-time charges relating to our
agreement with AOL and the cancellation of two bandwidth contracts during the
third quarter of 2001. Other charges during the third quarter of 2001 that
caused this increase include $2.3 million of additional internet access costs
in connection with our contract with AOL and $4.3 million of refile costs
that were higher than initially estimated in prior periods. The voice market
continued to suffer from extreme instability during the third quarter of
2001. Unusually high traffic due to the reduced number of carriers and
volatility among suppliers we use to terminate traffic significantly
increased our termination costs and negatively affected our gross margin. We
expect, as we continue to optimize our supplier base and the overall market
stabilizes, that these factors, and their adverse effect on gross margins,
may abate.
OPERATING EXPENSES
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES: Selling, general and
administrative expenses were approximately $18.5 million for the three months
ended September 30, 2001, representing a 113% increase over the three months
ended September 30, 2000 of approximately $8.7 million. Expressed as a
percentage of revenues, selling, general and administrative expenses
increased from 11% in the third quarter of 2000 to 21% in the third quarter
of 2001. This increase was primarily attributable to increases in bad debt
expense, our number of employees, severance charges and the hiring of top-level
management.
Bad debt expense totaled $2.2 million and ($0.2) million for the
three months ended September 30, 2001 and 2000, respectively. Bad debt
expense for the third quarter of 2001, specifically relating to the voice
business, was higher due to our further efforts to trim our customer base.
During the third quarter of 2001, we continued to reduce the number of
companies connected to our pan-European network to reduce potential credit
risks.
A portion of the increase in selling, general and administrative
expenses related to additional personnel costs, in particular an increase of
our sales force, information technology costs, office costs and professional
fees and expenses necessary to manage and administer our overall growth. We
employed approximately 70 more employees during the third quarter of 2001
than during the third quarter of 2000. In addition, during the third quarter
of 2001, we incurred expenses related to employee terminations prior to the
restructuring of the company and costs associated with the hiring of
top-level management. Comparable personnel costs were not incurred in any
significant amount during the third quarter of 2000.
DEPRECIATION AND AMORTIZATION: Depreciation and amortization expenses
increased from $9.2 million for the three months ended September 30, 2000 to
$18.4 million for the three months ended September 30, 2001. The increase was
primarily attributable to the additional investments in metro rings, ducts,
fiber, cables, electronics, network equipment, and the build-out of data
centers during the fourth quarter of 2000 and first nine months of 2001. Once
again, the additional investments are mainly attributable to growth of demand
for our services and the geographic expansion of our network footprint. Based
on impairment charges, as discussed below, we expect depreciation and
amortization to reduce significantly in future periods.
RESTRUCTURING: In the third quarter of 2001, we recorded a restructuring
charge of $15.9 million. The restructuring charge was related to the lease
cancellation penalties and lease costs for sales and administrative offices
including Berlin, Brussels, Dusseldorf, Madrid, Saarbruken and Vienna and
data centers, the elimination of approximately 125 employees from within each
business segment and geographic area of the company and in all major
functions, and the write-down of assets to their fair market value for
certain furniture and fixtures at the offices mentioned above. We currently
estimate that the restructuring initiatives will results in annual cost
savings of approximately $15 million.
21
<Page>
IMPAIRMENT OF LONG-LIVED ASSETS. Carrier1 conducted a review of its assets
under SFAS 121 in the third quarter of 2001 and made total write-downs of
approximately $429.2 million. See Notes 3 and 11 in Carrier1's unconsolidated
financial statements. No such write-downs were made in the same period of
2000.
In light of recent conditions in the telecommunications industry and
the world economy, Carrier1 conducted a review of the carrying amount of its
network assets. It determined that the network assets group was the lowest
level within property and equipment at which cash flows could be reliably
identified and estimated. Carrier1 has concluded that the estimated future
undiscounted cash flows expected to be generated by its network assets would
be less than their carrying amount. As a result of the review, Carrier1
recorded an asset impairment charge in the third quarter of 2001 of
approximately $370.2 million relating to the write-down of the carrying value
of its network assets to their estimated fair values based on a third party
valuation analysis. The valuation analysis used to ascertain fair value
reflected the value of the assets as a going concern and discussed
contemplates retention of the network assets at their present location for
continuation as part of the current operations. The valuation analysis
included the cost, income and market approaches to valuation of assets, with
primary consideration given to the income approach on the basis of projected
earnings and cash flows.
In addition to the write down of its network assets, Carrier1
wrote-down approximately $59.0 million of other impaired long-lived assets.
These write-downs primarily included $29.2 million on its investment in
DigiPlex S.A., $3.2 million on its investment in Servecast.com Ltd. and $26.2
million on network assets located in the United Kingdom. The remaining
write-down related to other equity investments. Based on recent industry
trends and management's current expectation for the sector, sustained benefit
from these assets is unlikely. Based on Carrier1's analysis of future
undiscounted net cash flow estimates, these assets have been written-down to
their estimated fair value, which was determined by discounting the net
future anticipated cash flows.
EARNINGS BEFORE INTEREST, TAXES, DEPRECIATION AND AMORTIZATION ("EBITDA")
We define EBITDA as earnings before interest, taxes, depreciation,
amortization, restructuring, impairment of long-lived assets, foreign
currency exchange gains or losses, other income (expense) and extraordinary
items. Our EBITDA for the three months ended September 30, 2001 reflected a
loss of $45.7 million, compared with a loss of $8.5 million for the three
months ended September 30, 2000. This increase in our EBITDA loss is
primarily attributable to the volume increases in our voice services,
additional network operating costs, cancellation charges and delivery
penalties, bad debt expense, increased number of employees, severance related
charges and the hiring of top-level management. In addition, our EBITDA
margin declined from (11)% for the three months ended September 30, 2000 to
(53)% for the three months ended September 30, 2001. This decline is
primarily attributable to the increase in the costs mentioned above, as well
as the discontinuation of certain customer relationships.
EBITDA IS USED BY OUR MANAGEMENT AND CERTAIN INVESTORS AS AN
INDICATOR OF OUR ABILITY TO SERVICE DEBT AND TO SATISFY OUR CAPITAL
REQUIREMENTS. HOWEVER, EBITDA IS NOT A MEASURE OF FINANCIAL PERFORMANCE UNDER
US GAAP AND SHOULD NOT BE CONSIDERED AS AN ALTERNATIVE TO CASH FLOWS FROM
OPERATING, INVESTING OR FINANCING ACTIVITIES AS A MEASURE OF LIQUIDITY OR AN
ALTERNATIVE TO NET INCOME AS AN INDICATION OF OUR OPERATING PERFORMANCE OR
ANY OTHER MEASURE OF PERFORMANCE DERIVED UNDER US GAAP. EBITDA AS USED IN
THIS REPORT MAY NOT BE COMPARABLE TO OTHER SIMILARLY TITLED MEASURES OF OTHER
COMPANIES OR TO SIMILARLY TITLED MEASURES AS CALCULATED UNDER OUR DEBT
AGREEMENTS.
OTHER INCOME (EXPENSE)
INTEREST EXPENSE AND INTEREST INCOME. Net interest expense was approximately
$4.4 million during the three months ended September 30, 2001 compared to
approximately $2.6 million for the three months ended September 30, 2000.
Interest income was approximately $3.4 million during the three months ended
September 30, 2001 compared with approximately $5.5 million for the three
months ended September 30, 2000. This decrease is primarily attributable to
the various sales of our marketable securities during the first nine months
of 2001. Interest expense was approximately $7.8 million during the three
months ended September 30, 2001 compared to approximately $8.1 million for
the three months ended September 30, 2000. This decrease from the three
months ended September 30, 2000 is primarily attributable to $0.3 million of
interest that was capitalized during the three months ended September 30,
2001, as compared to $0.2 million of interest that was capitalized during the
three months ended September 30, 2000, as well as currency translation effect.
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CURRENCY EXCHANGE GAIN (LOSS)-NET. Currency exchange gain (loss), net, was
approximately $19.0 million during the three months ended September 30, 2001
compared to approximately ($10.3) million for the three months ended September
30, 2000. The improvement in the currency exchange gain (loss), net, is a result
of the U.S. dollar weakening against most European currencies during the third
quarter of 2001 while it strengthened against such currencies during the third
quarter of 2000.
LOSS BEFORE INCOME TAX (EXPENSE) BENEFIT AND EXTRAORDINARY ITEM
Our loss before income tax (expense) benefit and extraordinary item was
approximately $494.7 million during the three months ended September 30, 2001
compared to approximately $30.6 million for the three months ended September 30,
2000. The increase in our loss is due to the aforementioned changes in revenues
and expenses.
INCOME TAX (EXPENSE) BENEFIT
For both periods, we generated tax losses on ordinary activities and
therefore did not incur significant income tax obligations. We have recorded a
valuation allowance for the full amount of any tax loss carryforwards generated
in each of the two periods.
NINE MONTHS ENDED SEPTEMBER 30, 2001 AS COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 2000:
REVENUE
Revenue increased 54% from $185.4 million for the nine months ended
September 30, 2000 to $284.6 million for the nine months ended September 30,
2001. We divide our revenue into two principal categories: voice services
revenue and data services revenue. Voice services revenue increased 20% from
$158.1 million for the nine months ended September 30, 2000 to $189.3 million
for the nine months ended September 30, 2001. Data services revenue increased
249% from $27.3 million for the nine months ended September 30, 2000 to $95.3
million for the nine months ended September 30, 2001.
The increase in revenue from the prior year's nine-month period
reflects significant growth in demand for our service offerings from both new
and existing customers, a variety of new service introductions and a
significant expansion of our market. During 2000 and into the first nine
months of 2001, we have focused on developing a number of enhanced voice
services and data services, such as Internet access, value added Internet
transport, a VISP platform, as well as a variety of content distribution and
caching service offerings. Another focal point was the development of
partnerships with other data services providers to facilitate distribution of
our core services and provide better end-user functionality to our customer's
customers.
VOICE SERVICES: Revenue from wholesale voice services and enhanced voice
services increased 20% from $158.1 million for the nine months ended
September 31, 2000 to $189.3 million for the nine months ended September 30,
2001. Voice traffic volume during the nine months ended September 30, 2001
increased approximately 42% over the nine months ended September 30, 2000.
The average revenue per minute during the nine months ended September 30,
2001 decreased by approximately 16% from the nine months ended September 30,
2000. The price decrease reflects a change in traffic mix as well as overall
price decreases for voice services as a result of increased competition. We
believe prices may stabilize if the number of direct competitors decreases as
the telecommunications industry continues to experience business failures and
further consolidation.
The voice volume increases from the nine months ended September 30,
2000 to the nine months ended September 30, 2001 were not only driven by the
growth in our customer base, the build-out of our network, the formation of
subsidiaries and the establishment of sales teams in the Nordic countries,
Italy and Spain, but were also due to the launch of new enhanced services.
We have continued to implement the actions outlined in our previous
quarter's Form 10-Q filing such as the discontinuance of commercial
relationships with voice customers and voice customer groups that may expose
us to bad debt in the future or provide us with an inadequate return on
capital. We believe that these actions have been successful to date, however,
such actions might decrease our revenues over the short to medium term.
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DATA SERVICES: Repetitive data services revenue - the revenue we derive from
Internet transport, Internet access services, bandwidth, infrastructure, and
data center services - increased 318% from $18.4 million for the nine months
ended September 30, 2000 to $77.0 million for the nine months ended September
30, 2001. This increase was primarily driven by increases in revenues from
bandwidth, infrastructure and VISP services. Non-recurring data revenue, or
one-time sales, such as duct, bandwidth IRU, and fiber sales were
approximately $18.3 million and $8.9 million during the nine months ended
September 30, 2001 and 2000, respectively. This increase was primarily the
result of two sales of fiber optic cable which resulted in revenue of $11.8
million during the first nine months of 2001. The increase from the nine
months ended September 30, 2000 to September 30, 2001, was offset by one
bandwidth IRU contract for $4.2 million that qualified as a sales-type lease
during the first nine months of 2000. We expect that data services revenue as
a percentage of total revenue will continue to increase due to the
implementation of existing service contracts, the introduction of new
services, and the likelihood of winning new customers as a result of our
expanded services.
COST OF SERVICES
Cost of services (exclusive of items shown separately) increased by
63% from $189.3 million for the nine months ended September 30, 2000 to
$307.8 million for the nine months ended September 30, 2001. Depreciation of
our network assets is included in depreciation and amortization.
Cost of services consists of voice and Internet interconnection and
termination costs, network operating costs, transmission costs, temporary or
permanent leases for transmission capacity and costs related to duct,
bandwidth IRU, and fiber sales. The increase from the nine months ended
September 30, 2000 to the nine months ended September 30, 2001 was primarily
attributable to: interconnection payments associated with the volume increase
in traffic for our voice services; additional network operating costs
associated with the increased demand for our repetitive data services; the
development of new services; and our geographic expansion. In addition, VISP
termination costs were new during 2001. We incurred $12.0 million of one-time
charges relating to our agreement with AOL and the cancellation on two
bandwidth contracts during the first nine months of 2001. Other charges
during the first nine months of 2001 that caused this increase include $2.3
million of additional internet access costs in connection with our contract
with AOL and $4.3 million of refile costs that were higher than initially
estimated in prior periods. The voice market suffered from extreme
instability during the first nine months of 2001. Unusually high traffic due
to the reduced number of carriers and volatility among suppliers we use to
terminate traffic significantly increased our termination costs and
negatively affected our gross margin. We expect as we continue to optimize
our supplier base and the overall market stabilizes, that these factors, and
their adverse effect on gross margins, may abate.
OPERATING EXPENSES
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES: Selling, general and
administrative expenses increased 162% from $25.5 million for the nine months
ended September 30, 2000 to $66.9 million for the nine months ended September
30, 2001. This increase was primarily attributable to bad debt expense of
$25.9 million for the nine months ended September 30, 2001 as compared to
$0.9 million for the nine months ended September 30, 2000. We increased our
provision due to concerns over the economic viability of some of our
customers, primarily in the voice services segment, that have been negatively
impacted by the recent economic slowdown. We have since ceased our
relationship with most of such customers and expect this to have a
stabilizing effect on our bad debt expense in the future. A portion of the
increase in selling, general and administrative expenses related to
additional personnel costs, in particular an increase of our sales force,
information technology costs, office costs and professional fees and expenses
necessary to manage and administer our overall growth. Expressed as a
percentage of revenues, selling, general and administrative expenses
increased from 14% in the nine months ended September 30, 2000 to 24% in the
nine months ended September 30, 2001. This increase was primarily driven by
the significant amount of bad debt expense. Excluding bad debt expense, our
selling, general and administrative expenses expressed as a percentage of our
revenue increased only slightly from 13% for the nine months ended September
30, 2000 to 14% for the nine months ended September 30, 2001.
DEPRECIATION AND AMORTIZATION: Depreciation and amortization expenses
increased from $22.6 million for the nine months ended September 30, 2000 to
$48.0 million for the nine months ended September 30, 2001. The increase was
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primarily attributable to the completion and initial operation of our German
fiber ring, additional investments in metro rings, ducts, fiber, cables,
electronics, network equipment, and the build-out of data centers. Once
again, these additional investments are mainly attributable to growth of
demand for our services and our geographic expansion of the network
footprint. Based on impairment charges, as discussed below, we expect
depreciation and amortization to reduce significantly in future periods.
RESTRUCTURING: In the third quarter of 2001, we recorded a restructuring
charge of $15.9 million. The restructuring charge was related to the lease
cancellation penalties and lease costs for sales and administrative offices
including Berlin, Brussels, Dusseldorf, Madrid, Saarbruken and Vienna and
data centers, the elimination of approximately 125 employees from within each
business segment and geographic area of the company and in all major
functions, and the write-down of assets to their fair market value for
certain furniture and fixtures at the offices mentioned above. We currently
estimate that the restructuring initiatives will results in annual cost
savings of approximately $15 million.
IMPAIRMENT OF LONG-LIVED ASSETS. Carrier1 conducted a review of its assets
under SFAS 121 in the third quarter of 2001 and made total write-downs of
approximately $429.2 million. See Notes 3 and 11 in Carrier1's unconsolidated
financial statements. No such write-downs were made in the same period of
2000.
In light of recent conditions in the telecommunications industry and
the world economy, Carrier1 conducted a review of the carrying amount of its
network assets. It determined that the network assets group was the lowest
level within property and equipment at which cash flows could be reliably
identified and estimated. Carrier1 concluded that the estimated future
undiscounted cash flows expected to be generated by its network assets would
be less than their carrying amount. As a result of the review, Carrier1
recorded an asset impairment charge in the third quarter of 2001 of
approximately $370.2 million relating to the write-down of the carrying value
of its network assets to their estimated fair values based on a third party
valuation analysis. The valuation analysis used to ascertain fair value
reflected the value of the assets as a going concern and discussed
contemplates retention of the network assets at their present location for
continuation as part of the current operations. The valuation analysis
included the cost, income and market approaches to valuation of assets, with
primary consideration given to the income approach on the basis of projected
earnings and cash flows.
In addition to the write down of its network assets, Carrier1
wrote-down approximately $59.0 million of other impaired long-lived assets.
These write-downs primarily included $29.2 million on its investment in
DigiPlex S.A., $3.2 million on its investment in Servecast.com Ltd. and $26.2
million on network assets located in the United Kingdom. The remaining
write-down related to other equity investments. Based on recent industry
trends and management's current expectation for the sector, sustained benefit
from these assets is unlikely. Based on Carrier1's analysis of future
undiscounted net cash flow estimates, these assets have been written-down to
their estimated fair value, which was determined by discounting the net
future anticipated cash flows.
EARNINGS BEFORE INTEREST, TAXES, DEPRECIATION AND AMORTIZATION ("EBITDA")
We define EBITDA as earnings before interest, taxes, depreciation,
amortization, restructuring, impairment of long-lived assets, foreign
currency exchange gains or losses, other income (expense) and extraordinary
items. Our EBITDA for the nine months ended September 30, 2001 reflected a
loss of $90.0 million, compared with a loss of $29.5 million for the nine
months ended September 30, 2000. This increase in our EBITDA loss is
primarily attributable to bad debt expense, volume increases in our voice
services, additional network operating costs, cancellation charges and
delivery penalties, increased number of employees, severance related charges
and the hiring of top-level management. In addition, our EBITDA margin
declined from (16)% for the nine months ended September 30, 2000 to (32)% for
the nine months ended September 30, 2001. This decline is primarily
attributable to the increase in bad debt expense. Excluding bad debt expense,
our EBITDA expressed as a percentage of our revenue has declined from (15)%
for the nine months ended September 30, 2000 to (23)% for the nine months
ended September 30, 2001. This decrease is primarily attributable to the
volume increases in our voice services, additional network operating costs,
cancellation charges and delivery penalties, number of employees, severance
related charges and the hiring of top-level management, as well as the
discontinuation of certain customer relationships.
EBITDA IS USED BY OUR MANAGEMENT AND CERTAIN INVESTORS AS AN
INDICATOR OF OUR ABILITY TO SERVICE DEBT AND TO SATISFY OUR CAPITAL
REQUIREMENTS. HOWEVER, EBITDA IS NOT A MEASURE OF FINANCIAL PERFORMANCE UNDER
US GAAP AND SHOULD NOT BE CONSIDERED AS AN ALTERNATIVE TO CASH FLOWS FROM
OPERATING, INVESTING OR FINANCING ACTIVITIES AS A MEASURE OF LIQUIDITY OR AN
ALTERNATIVE TO NET INCOME AS AN INDICATION OF OUR OPERATING PERFORMANCE OR
ANY OTHER MEASURE OF
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PERFORMANCE DERIVED UNDER US GAAP. EBITDA AS USED IN THIS REPORT MAY NOT BE
COMPARABLE TO OTHER SIMILARLY TITLED MEASURES OF OTHER COMPANIES OR TO
SIMILARLY TITLED MEASURES AS CALCULATED UNDER OUR DEBT AGREEMENTS.
OTHER INCOME (EXPENSE)
INTEREST EXPENSE AND INTEREST INCOME. Net interest expense increased from
$9.3 million for the nine months ended September 30, 2000 to $13.8 million
for the nine months ended September 30, 2001. Interest income decreased from
$14.6 million for the nine months ended September 30, 2000 to $10.1 million
for the nine months ended September 30, 2001. This decrease was primarily
attributable to the various sales of our marketable securities during the
nine months ended September 30, 2001. Interest expense remained consistent at
$23.9 million for the nine months ended September 30, 2001 and 2000.
CURRENCY EXCHANGE GAIN (LOSS)-NET. Currency exchange loss, net, decreased
91% from $26.1 million for the nine months ended September 30, 2000 to $2.3
million for the nine months ended September 30, 2001. During the first nine
months of 2001, the U.S. dollar strengthened against most European currencies
to a lesser extent than during the first nine months of 2000, primarily due
to the weakening of the U.S. dollar during the third quarter of 2001 which
led to a currency exchange gain of $19.0 million during that period. This
decrease was offset by the difference in the change in functional currency of
the Luxembourg holding company that reduced the currency exchange loss, net,
reported in the unaudited statement of operations by $12.9 million for the
nine months ended September 30, 2001 as compared to $17.8 million for the
three months ended September 30, 2000, as described under the caption
"-Liquidity and Capital Resources."
LOSS BEFORE INCOME TAX (EXPENSE) BENEFIT AND EXTRAORDINARY ITEM
Our loss before income tax (expense) benefit and extraordinary item
increased from $87.5 million for the nine months ended September 30, 2000 to
$599.3 million for the nine months ended September 30, 2001 due to the
aforementioned changes in revenues and expenses.
INCOME TAX (EXPENSE) BENEFIT
For both periods, we generated tax losses on ordinary activities and
therefore did not incur significant tax obligations. We have recorded a
valuation allowance for the full amount of any tax loss carryforwards
generated in each of the two periods.
EXTRAORDINARY LOSS ON EARLY EXTINGUISHMENT OF DEBT
For the nine months ended September 30, 2000, an after-tax
extraordinary loss of $3.8 million resulted from the early retirement of an
interim credit agreement with Morgan Stanley Senior Funding, Inc. and
Citibank N.A. and a financing facility with Nortel Networks Inc. These
facilities were repaid as part of our initial public offering as described
under the caption "-Liquidity and Capital Resources."
LIQUIDITY AND CAPITAL RESOURCES
OVERVIEW
The costs associated with the initial installation and expansion of
our networks, including development, installation and initial operating
expenses, have been, and in new markets are expected to be, significant and
have resulted in and will continue to result in negative cash flow. Negative
cash flow is expected to continue until an adequate customer base and related
revenue stream have been established. We believe that our operating losses
and negative cash flow will continue into 2002 as we selectively expand our
networks and service offerings.
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CASH FLOW INFORMATION
Net cash (used in) provided by operating activities decreased to
($96.3) million for the nine months ended September 30, 2001 compared to
$10.7 million for the nine months ended September 30, 2000. The decrease was
primarily derived from increases in net loss and changes in receivables.
Net loss for the nine months ended September 30, 2001 was $599.6
million compared with $91.3 million for the nine months ended September 30,
2000. The changes related to these amounts are discussed in the three and
nine months ended September 30, 2001 and 2000 discussion and analysis above.
Receivables, which includes accounts, increases in unbilled and
value-added tax (VAT), refunds receivable, increased by $51.9 million to
$169.0 million at September 30, 2001 compared to an increase of $44.8 million
for the nine months ended September 30, 2000. Receivables increased during
these periods as a result of increased volume and number of customers as well
as difficulties in collecting certain receivables due to worsening economic
conditions in the telecommunications industry. During the third quarter of
2001, we collected approximately $32 million of net VAT refunds and expect an
additional $8 million from various governmental institutions before year-end,
although there can be no assurance that we will indeed collect that amount.
The increase in receivables was offset by increases in accounts
payable and accrued liabilities. Accounts payable and accrued liabilities
increased by $64.8 million to $220.9 million for the nine months ended
September 30, 2001 compared to an increase of $49.2 million for the nine
months ended September 30, 2000. Accounts payable and accrued liabilities
increased during these periods due to the continued expansion of the business
and the cancellation of the AOL contract discussed above. For the nine months
ended September 30, 2001, approximately $11.3 million of the increase was
also attributable to our restructuring of operations.
We used $39.3 million in cash for net investing activities during
the nine months ended September 30, 2001 compared to $124.0 million during
the nine months ended September 30, 2000. We paid $170.1 million for property
and equipment during the nine months ended September 30, 2001 compared to
$153.7 million for the nine months ended September 30, 2000, in order to
invest in fiber infrastructure and transmission equipment. The 2001
expenditures included payments for major infrastructure projects including
the German network, the Hanover cross-connect, the development of the
Southern Ring, and the UK network. We plan to continue investing in targeted
infrastructure projects, such as select metropolitan networks. In addition,
we sold $183.2 million of available-for-sale securities during the first nine
months of 2001 to help fund operating deficits, capital expenditures, and
reduce foreign exchange risk. We purchased $76.8 million of U.S. Treasury
Bonds to mitigate against significant foreign exchange risk arising from U.S.
dollar denominated liabilities.
Net cash provided by financing activities was $12.4 million
consisting primarily of released restricted cash, during the nine months
ended September 30, 2001 compared to $562.0 million during the nine months
ended September 30, 2000. On March 1, 2000, we completed our initial public
offering of 8,625,000 shares of common stock (including the underwriters'
overallotment of 1,125,000 shares) at a price of (u)87 per share
(approximately $87.42 per share). We received proceeds of approximately
$681.6 million, net of underwriting discounts and commissions, listing
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fees, and offering-related expenses. The net cash provided was used to help
fund purchases of property and equipment, investments, operating losses and
the repayment on a portion of the long-term debt that was incurred during
1999.
On February 19, 1999, Carrier1 International S.A. issued $160
million and (u)85 million (currently $77.3 million) of 13 1/4% senior notes,
with a scheduled maturity of February 15, 2009, with warrants which were
subsequently detached from the notes. These notes contain covenants which
significantly restrict Carrier1's operational flexibility, in that they
restrict Carrier1's ability to enter into certain transactions including, but
not limited to, incurring additional indebtedness, creating liens, paying
dividends, redeeming capital stock, selling assets, issuing or selling stock
of restricted subsidiaries, or effecting a consolidation or merger. On
November 6, 2001, Carrier1 commenced a cash Tender Offer and consent
solicitation for amendments to the indentures for all of Carrier1's
outstanding high yield senior notes, as discussed below.
As required by the terms of the notes, Carrier1 International S.A
used approximately $49.2 million of the net proceeds to purchase a portfolio
of U.S. Government securities and approximately (u)26.9 million ($29.8
million) of the net proceeds to purchase a portfolio of European government
securities, and pledged these portfolios for the benefit of the holders of
the respective series of notes to collateralize and fund the first five
interest payments. As of September 30, 2001, the escrow funds set aside to
fund these five interest payments on the notes have now been used in full and
our balance of restricted investments was reduced to $0. As a result, the
notes, which are obligations of Carrier1 International S.A. (and not of its
subsidiaries) are not secured in any way.
On February 18, 1999, we entered into an agreement to purchase fiber
optic cable for the German network for $20.3 million plus value-added tax.
The outstanding balance was repaid from the proceeds of our initial public
offering during the third quarter of 2000.
In June 1999, we entered into a financing facility with Nortel
Networks Inc., an equipment supplier. Prior to the repayment of this debt
during the first quarter of 2000, we had borrowed substantially the full
amount of the $75 million available under the facility. The debt outstanding
under this facility bore interest at a LIBOR-based floating interest rate,
and the weighted average interest rate on outstanding amounts was 11.04% as
of December 31, 1999. The debt was repaid from the proceeds of our initial
public offering and resulted in an after-tax extraordinary loss of $1.6
million.
In December 1999, we entered into an interim credit agreement with
Morgan Stanley Senior Funding, Inc. and Citibank N.A. As of December 31,
1999, we had borrowed (u)10 million ($10.1 million) of the $200.0 million (or
the euro equivalent) available under the facility. During the first quarter
of 2000, we incurred additional indebtedness of (u)30 million (approximately
$29.7 million) related to this facility. This debt bore interest at a
LIBOR-based floating interest rate equal to 6.72% as of December 31, 1999.
The debt outstanding under this facility was repaid in 2000 from the proceeds
of our initial public offering, and the facility terminated. This debt
retirement resulted in an after-tax extraordinary loss of $2.2 million in
2000.
Subsequent to the third quarter, on November 6, 2001, Carrier1
announced a Tender Offer for all of its outstanding high-yield notes. The
purchase price in the Tender Offer is (u)182.50 per (u)1,000 tendered on the
(u)85 million in 13.25% senior euro notes due 2009 and $182.50 per $1,000
tendered on the $160 million in 13.25% senior dollar notes due 2009, plus
accrued and unpaid interest.
Current conditions in the capital markets make it unlikely that we
will be able to raise additional capital to refinance our long-term debt or
fund our operations, given our operating performance and existing capital
structure. As a result, we now believe that we could experience difficulty in
meeting our August 2002 interest payment obligations on the euro and dollar
senior notes. Considering our financial condition and business prospects in
the current economic climate, we recognized restructuring and impairment of
long-lived asset charges during the three months ended September 30, 2001.
However, we do not believe that these steps alone will be adequate
to assure continued funding of our operations and believe that a significant
reduction in indebtedness is also required. As a result, we initiated the
Tender Offer described above. If successful, this will significantly decrease
our interest burden and is expected to improve our ability to continue to
fund our operations.
Assuming that the cash tender offers were consummated with effect on
September 30, 2001 and that 100% of the aggregate principal amount of the
Notes had been tendered, accepted for purchase and paid for at the purchase
price, together with accrued and unpaid interest thereon, on a pro forma
basis, as of September 30, 2001, we would have had no long-term debt
outstanding and approximately $77 million in cash and cash equivalents,
restricted cash, restricted investments and available-for-sale securities.
If the Tender Offer is successful, Carrier1 expects to recognize an
accounting gain approximately equal to the difference between the nominal
value of the notes and the purchase price for all notes purchased, but does
not expect completion of the Tender Offer and adoption of the proposed
amendments to result in any tax liability to the Carrier1 group.
Payment of the purchase price and interest on completion of the
Tender Offer, if it is successful, will significantly reduce the Company's
total cash resources. Such significant reduction may have a material adverse
effect on the Company's funding and liquidity position. The amount of any
such reduction would depend upon the level of success of the Tender Offer.
Carrier1's ability to continue to fund its operations depends upon whether it
can reduce capital expenditure and costs significantly, eliminate all or a
substantial portion of its debt and conserve cash required to fund its
operations until it is cash-flow positive.
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Other factors that will affect the amount of future capital
requirements include:
- the overall success of our business;
- any acquisitions or investments we make;
- the start-up of each additional segment of our network;
- the dates on which we further expand our network;
- whether our selected network build-out is on-time and
on-budget;
- on-going reductions in our capital expenditures and
operating expenses;
- the types of services we may offer in the future;
- staffing levels;
- customer growth; and
- the overall economic situation over the foreseeable future.
Additional factors that are not within our control, including
competitive conditions and government regulatory developments, may also
impact our future capital requirements. Depending on the factors listed
above, we may need to issue additional debt, secure additional credit or
vendor financing facilities, continue to delay or reduce some or all of our
development and expansion plans or may be required to seek other sources of
funding. Carrier1 may not be able to secure any such financing, if and when
it is needed. Our inability to secure additional funding may have a material
adverse effect on our business.
FOREIGN CURRENCY
We report our financial results in U.S. dollars. We make interest
and principal payments on our 13 1/4% senior notes in U.S. dollars and euros.
However, the majority of our revenues and operating costs are derived from
sales and operations outside the United States and incurred in a number of
different currencies. Accordingly, fluctuations in currency exchange rates
may have a significant effect on our results of operations and balance sheet
data.
During the third quarter of 2000, Carrier1 determined that the
functional currency of the Luxembourg holding company, Carrier1 International
S.A., had changed from the U.S. dollar to the euro due to significant changes
in economic facts and circumstances underlying our business. The functional
currencies of our subsidiaries have not changed and, in all instances, are
the respective local currency.
We applied this change prospectively as of the beginning of the
third quarter of 2000. As a result of this change, transactions entered into
by the holding company that are denominated in currencies other than the euro
are now translated into euros in accordance with Statement of Financial
Accounting Standards No. 52, "Foreign Currency Translation."
The net effect of this change in functional currency for the nine
months ended September 30, 2001 was to decrease the currency exchange loss
(net) and the net loss reported in the unaudited statement of operations by
approximately $12.9 million and to increase the negative currency translation
adjustment component of other comprehensive loss reported in the statement of
shareholders' equity by approximately $12.9 million for the nine months ended
September 30, 2001. For the three months ended September 30, 2000 the effect
was to reduce the currency exchange loss (net) and the net loss reported in
the statement of operations by approximately $17.8 million and to increase
the negative currency translation adjustment component of other comprehensive
loss reported in the statement of shareholders' equity by approximately $17.8
million.
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<Page>
The euro has eliminated exchange rate fluctuations among the 11
participating European Union member states. Adoption of the euro has
therefore reduced the degree of intra-Western European currency fluctuations
to which we are subject. We will, however, continue to incur revenues and
operating costs in non-euro denominated currencies, such as pounds sterling.
Although we do not currently engage in any off-balance sheet
exchange rate-hedging strategies, we may attempt to limit foreign exchange
exposure by purchasing forward foreign exchange contracts or engage in other
similar hedging strategies in the future. As a first step, during the third
quarter of 2001, we sold a portion of our euro-denominated available-for-sale
securities and purchased $76.8 million of U.S. Treasury Bonds to mitigate
against significant foreign exchange risk arising from U.S.
dollar-denominated liabilities.
NEW ACCOUNTING PRONOUNCEMENTS
In August 2001, the Financial Accounting Standards Board approved
SFAS 144 "Accounting for the Impairment or Disposal of Long-Lived Assets."
SFAS No. 144 supersedes SFAS 121, "Accounting for Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of" and the accounting and
reporting provisions of APB Opinion No 30, "Reporting the Results of
Operations - Reporting the Effects of Disposal of a Segment of a Business,
and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." SFAS No. 144 establishes a single accounting model, based on
the framework established in SFAS 121, for long-lived assets to be disposed
of by sale and resolved significant implementation issues related to SFAS
121. SFAS 144 retains the requirements of SFAS 121 to recognize an impairment
loss only if the carrying amount of a long-lived asset is not recoverable
from its undiscounted cash flows and measure an impairment loss as the
difference between the carrying amount and fair value of the asset. SFAS 144
excludes goodwill from its scope, describes a probability-weighted cash flow
estimation approach, and establishes a "primary-asset" approach to determine
the cash flow estimation period for groups of assets and liabilities. SFAS
144 is effective for fiscal years beginning after December 15, 2001, and
interim periods within those fiscal years, with early application encouraged.
The Company will apply SFAS 144 beginning January 1, 2002. As a result of the
impairment charge recorded during the third quarter of 2001, Carrier1 does not
believe the adoption of SFAS 144 will have a material effect on Carrier1's
financial position, results of operations or cash flows.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Because our outstanding debt at September 30, 2001 is fixed-rate
debt, a change in market interest rates has no material effect on our
earnings, cash flows or financial condition.
We are exposed to market risk from changes in foreign currency
exchange rates. Our market risk exposure exists from changes in foreign
currency exchange rates associated with our non-derivative financial
instruments, such as our 13 1/4% senior dollar notes, and with transactions
in currencies other than local currencies in which we operate. As of
September 30, 2001, we did not have an off-balance sheet position in futures,
forwards, swaps, options or other similar financial instruments to manage the
risk arising from our foreign currency exchange rate exposures. However,
during the third quarter of 2001, we sold a portion of our euro-denominated
available-for-sale securities and purchased $76.8 million of U.S. Treasury
Bonds to mitigate against significant foreign exchange risk arising from U.S.
dollar-denominated liabilities.
In addition, we have foreign currency exposures related to
purchasing services and equipment and selling our services in currencies
other than the local currencies in which we operate. The introduction of the
euro has significantly reduced the degree of intra-Western European currency
fluctuations to which we are subject as of September 30, 2001, although we
are still exposed to exchange rate risk relating to fluctuations in
currencies that were not converted to the euro, such as the British pound and
the Swiss franc. Our assets, liabilities, revenues and expenses denominated
in these currencies are substantial. Additionally, we are exposed to cash
flow risk related to debt obligations denominated in foreign currencies,
particularly our 13 1/4% senior dollar notes.
The table below presents principal cash flows and related average
interest rates for our obligations by expected maturity dates as of September
30, 2001. The information is presented in U.S. dollar equivalents, our
reporting currency, using the exchange rate at September 30, 2001. The actual
cash flows are payable in either U.S. dollars ($) or euro (u), as
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indicated in the parentheses. Fair value of the dollar and euro notes was
estimated based on quoted market prices as of September 30, 2001. Fair value
for all other debt obligations was estimated using discounted cash flows
analyses, based on our borrowing rate as of September 30, 2001.
<Table>
<Caption>
EXPECTED MATURITY DATE 2001 2002 2003 2004 2005 THEREAFTER TOTAL FAIR VALUE
- ---------------------- ---- ---- ------- -------- -------- ------------- --------- ------------
(IN THOUSANDS)
Notes payable:
Fixed rate (u) $77,343 $77,343 $6,961
Interest rate 13.25% 13.25%
Fixed rate ($) $160,000 $160,000 $14,400
Interest rate 13.25% 13.25%
Other long-term debt:
Fixed rate ($) $736 $753 $1,489 $1,489
Interest rate 9.7% 9.7%
</Table>
The cash flows in the table above are presented in accordance with
the maturity dates defined in the debt obligations. However, the dollar and
euro notes allow for early redemption at specified dates in stated principal
amounts, plus accrued interest. Subsequent to the third quarter of 2001, we
have initiated the Tender Offer to purchase all our euro and dollar notes.
Cash flows associated with the purchase and subsequent early redemption or
cancellation of these debt obligations are not assumed in the table above.
Should any of the amounts be redeemed or cancelled following the Tender
Offer, the cash flow amounts in the table above would change significantly.
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Rider 1a to come
PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We may from time to time be a party to litigation that arises in the
normal course of our business operations. Since our inception we have not
been, and we are not presently, a party to any litigation or arbitration that
we believe had or would reasonably be expected to have a material adverse
effect on our business or results of operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
RECENT SALES OF UNREGISTERED SECURITIES
During the quarterly period ended September 30, 2001, we issued 8,205
shares of our common stock in exchange for warrants that were exercised.
ITEM 5. OTHER INFORMATION
During the three month period ended September 30, 2001, each of Stig
Johansson, our previous Chief Executive Officer, and Kees van Ophem, our
previous Executive Vice President, Corporate Services and General Counsel,
retired from all corporate functions (including as management or board
member, or officer or any other similar function) in accordance with
retirement letters as filed with this Form 10-Q as Exhibits 10.5 and 10.7,
respectively, and entered into Severance Agreements with Carrier1
International GmbH, a wholly owned subsidiary of Carrier1, as filed with this
Form 10-Q as Exhibits 10.4 and 10.6, respectively.
On September 11, 2001, Carrier1 employed a new Chief Executive Officer,
Michael McTighe, on terms set forth in the Employment Agreement and Option
Agreement as filed with this Form 10-Q as Exhibits 10.1 and 10.2,
respectively. Mr. McTighe was appointed to the board of directors of Carrier1
on September 10, 2001.
On September 11, 2001, Carrier1 made certain amendments to its
Registration Rights Agreement with its executives (filed as Exhibit 10.13 to
Carrier1's Registration Statement on Form S-4 (No. 333-75195) as set forth in
the Amendment Agreement as filed with this Form as Exhibit 10.3.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
- --------------------- -----------
10.1 Employment Agreement, dated September 27, 2001, among
Carrier1 UK Limited, Carrier1 International S.A. and
Robert Michael McTighe.
10.2 Option Agreement, dated September 11, 2001, among Carrier 1 UK
Limited, Carrier1 International S.A. and Robert Michael
McTighe.
10.3 Amendment Agreement, dated September 11, 2001, by and
among Carrier1 International S.A. and Carrier One, LLC.
10.4 Separation Agreement, dated August 14, 2001, by and among
Carrier1 International GmbH and Stig Johansson.
10.5 Retirement Letter, dated August 14, 2001 of Stig
Johansson, retiring from all corporate functions.
10.6 Separation Agreement, dated September 19, 2001, by and among
Carrier1 International GmbH and Kees van Ophem.
10.7 Retirement Letter, dated September 19, 2001, of Kees van
Ophem, retiring from all corporate functions.
</Table>
(b) Reports on Form 8-K
We filed the following reports on Form 8-K during the fiscal quarter ended
September 30, 2001:
Form 8-K dated August 9, 2001, and filed with the Securities and Exchange
Commission on
August 9, 2001, indicating that we would announce our second quarter
results on August 14.
Form 8-K dated August 14, 2001, and filed with the Securities and Exchange
Commission on
August 14, 2001, announcing our second quarter results and the retirement
of our CEO.
Form 8-K dated November 7, 2001, and filed with the Securities and Exchange
Commission on
November 7, 2001, regarding our commencement of a
tender offer and consent solicitation relating to our high yield notes.
Form 8-K dated November 9, 2001, and filed with the Securities and
Exchange Commission
on November 9, 2001, announcing a conference call in
order to discuss our financial results for the period ended September 30,
2001.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
<Table>
CARRIER1 INTERNATIONAL S.A.
BY: /S/ ROBERT MICHAEL MCTIGHE
-----------------------------------------
Robert Michael McTighe
CHIEF EXECUTIVE OFFICER AND
DIRECTOR
(PRINCIPAL EXECUTIVE OFFICER)
Date: November 14, 2001
BY: /S/ ALEX SCHMID
-----------------------------------------
Alex Schmid
CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL OFFICER AND PRINCIPAL
ACCOUNTING OFFICER)
Date: November 14, 2001
</Table>
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